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Foreclosure, Bank Owned, and Short Sale Defined

FORECLOSURE is the legal process by which a mortgage or other lien holder, usually a lender, obtains a termination of a mortgagor's equitable right of redemption, either by court order or by operation of law (after following a specific statutory procedure). Usually a lender obtains a security interest from a borrower who mortgages or pledges an asset like a house to secure the loan. If the borrower defaults and the lender tries to repossess the property, courts of equity can grant the borrower the equitable right of redemption if the borrower repays the debt. While this equitable right exists, it is a cloud on title and the lender cannot be sure that it can successfully repossess the property. Therefore, through the process of foreclosure, the lender seeks to foreclose the equitable right of redemption and take both legal and equitable title to the property in fee simple. Other lien holders can also foreclose the owner's right of redemption for the other debts, such as for overdue taxes, unpaid contractors' bills, or overdue homeowners' association dues or assessments.

The foreclosure process, as applied to residential mortgage loans, is a bank or other secured creditor, selling or repossessing a parcel of real property (immovable property) after the owner has failed to comply with an agreement between the lender and borrower, called a "Mortgage" or "Deed of Trust". Commonly, the violation of the mortgage is a default in payment of a promissory note, secured by a lien on the property. When the process is complete, the lender can sell the property and keep the proceeds to pay of its mortgage and any legal costs, and it is typically said that "the lender has foreclosed its mortgage or lien". If the promissory note was made with a recourse clause, and the sale does not bring enough to pay the existing balance of principle and fees, the mortgagee can file a claim for a deficiency judgement.

BANK OWNED or REAL ESTATE OWNED (REO) is a class of property owned by a lender, typically a bank, government agency, or government loan insurer, after an unsuccessful sale at a foreclosure auction. A foreclosing beneficiary will typically set the opening bid at a foreclosure auction for at least the outstanding loan amount. If there are no bidders that are interested, then the beneficiary will legally repossess the property. This is commonly the case when the amount owed on the home is higher than the current market value of this foreclosure property, such as with a high loan-to-value mortgage following a real estate bubble. As soon as the beneficiary repossess the property it is listed on their books as REO and categorized as an asset (non-performing). The bank will then try to sell the home on the open market to recoup some of their losses.

SHORT SALE is a sale of real estate in which the sale proceeds fall short of the balance owed on the property's loan. It often occurs when a borrower cannot pay the mortgage loan on their property, but the lender decides that selling the property as a moderate loss is better than pressing the borrower. Both parties consent to the short sale process because it allows them to avoid foreclosure, which involves hefty fees for the bank and poorer credit report outcomes for the borrowers. This agreement, however, does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, known as the deficiency.

In a short sale, the bank or mortgage lender agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender. Neither side is "doing the other a favor;" a short sale is simply the most economic solution to a problem. Banks will incur a smaller financial loss than would result from foreclosure or continued non-payment. Borrowers are able to mitigate damage to their credit history, and partially control the debt. A short sale is typically faster and less expensive than a foreclosure. It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer.

Lenders often have loss mitigation departments that evaluate potential short sale transactions. The majority have pre-determined criteria for such transactions, but they may be open to offers, and their willingness varies. A bank will typically determine the amount of equity (or lack thereof), by determining the probable selling price from an appraisal, Broker Price Option (BPO), or Broker Opinion of Value (BOV).

Lenders may accept short sale offers or requests for short sales even if a Notice of Default has not been issued or recorded with the locality where the property is located. Given the unprecedented and overwhelming number of losses that mortgage lenders have suffered from mortgage failures that in part triggered the financial crisis of 2007-2010, they are now more willing to accept short sales than ever before. For "under water" borrowers who owe more on their mortgage than their property is worth and are having trouble selling, this presents an opportunity for them to avoid foreclosure as a result.